BDC Preview: Week Of February 19 – February 22, 2019

This may be a holiday shortened week, but the BDC Reporter foresees plenty of developments across a range of subjects that will be worth tracking.

Who’s Next ?: Clearly, the capital markets for both debt and equity are open for business where public Business Development Companies are concerned. Admittedly, there’s not been a flood of new capital raised but New Mountain Finance (NMFC) once again undertook a secondary stock offering at a premium to book value (even if that required some subsidizing by the External Manager) and Gladstone Capital (GLAD) entered into an equity distribution arrangement with Jefferies. On the fixed income side of the street, mid-sized BDC Fidus Investment (FDUS) launched a second Baby Bond not long after Saratoga Investment (SAR) piled on additional issuance to its own second Baby Bond offering, while Prospect Capital (PSEC) indefatigably continued to issue InterNotes, albeit in relatively small sizes. That’s all happened just in the month of February. Also worth mentioning – but less subject to the enthusiasms of the capital markets – multiple BDCs have been not only extending but expanding their secured debt financings, includingTPG Specialty (TSLX) and Hercules Capital (HTGC).

The question now – and we’ll be looking out this week and the next few weeks for the answer – who else amongst the 45 public BDCs out there will be tapping the market ? Several BDCs have previously vouchsafed that they have to raise material amounts of new capital to meet their business plans in 2019, and we’re already not that far away from beginning the third month of 2019. In no particular order, Pennant Park Investment (PNNT); Gladstone Capital (GLAD); Gladstone Investment; KCAP Financial (KCAP); and Ares Capital (ARCC) all have urgent business to do with the capital markets. Frankly, if all the BDCs that have announced their intention to adopt the new leverage rules allowed by the Small Business Credit Availability Act (“SBCAA”) – and we count 36 at different stages – are to achieve their self imposed leverage targets, the markets for new unsecured debt are going to be very busy, and the conference rooms of many BDCs will be filled with senior lenders renegotiating and increasing secured financings. Very often the process is inter-dependent as senior lenders look for additional junior capital to be raised before agreeing to higher debt commitments.

This is not just a matter of idle curiosity for the BDC Reporter. There is always the possibility that the market doors will swing closed again – as they did in December 2018-January 2019. That would be a major setback for many BDCs with high hopes for greater assets under management. The result might be having a substantially higher cost of capital to contend with as other, more expensive, solutions are cobbled together, which would wreak havoc with BDCs financial assumptions and ultimately with earnings per share. Or portfolio asset growth might be put on hold for some undetermined period. There are several BDCs whose earnings are just barely covering their dividend distributions and are counting on growing their balance sheet – and thus earnings – to “cover” their payout. Put that bigger portfolio plan on hold and dividend cuts might follow. So we’ll be watching out to see who comes to market – and just as importantly – who does not.

Medley Muddle: Last week, the battle over Medley Capital (MCC), Medley Management (MDLY) and non-traded but future public vehicle Sierra Income, took more twists and turns. Origami Capital, “a leading asset management firm” revealed that – by its account – has been offering to acquire MCC’s SBIC subsidiary since the spring of 2018 (!), but with no response. As a result the would-be buyer announced publicly its offer: “Origami would propose a cash consideration of $45,000,000. This represents 60.0% of Medley SBIC’s regulatory capital (or NAV) at September 30, 2018 and implies a 36.2% premium to the February 8 [th] closing share price of Medley Capital Corporation”. As anyone who’s followed how these unsolicited offers unfold, the response – once the proposed transaction became public knowledge – was not encouraging. In fact MCC denied ever having heard from Origami (who could forget such a great name for an asset manager ?): “Contrary to Origami’s public statements, the Company never received a proposal to buy the SBIC Subsidiary from Origami until yesterday”. Still, MCC promised to refer the “non binding” offer to the special committee established to review such matters. We may hear MCC’s formal response this week.

The BDC Reporter is still wondering if the SBA would countenance a transfer of the subsidiary to a third party. In fact, we’re not even sure if the SBA has approved the shifting of the MCC SBIC subsidiary to the proposed new Sierra Income fronted public entity. Admittedly, the Origami offer – while having conditions precedent in other areas – does not require the SBA to say yes:

We would work collaboratively with the U.S. Small Business Administration to ensure proper transfer of the SBIC license so that the fund would continue to operate and support the growth of its existing portfolio companies, but our proposed transaction would not be contingent on a successful transfer of the SBIC license.

That only raises more questions in the BDC Reporter’s mind, but we’re going to table them till we see how MCC responds.

Meanwhile, back on the main front where the related Medley organizations face off against an alliance of NextPoint Capital – the would-be investment advisor to a merged MCC-Sierra- and several dissatisfied MCC institutional shareholders, there was a further development. On Friday February 15, 2019, Arthur Ainsberg, Chairman of MCC’s Special Committee and an “independent” director, wrote an impassioned (open) letter to Institutional Shareholder Services (ISS). The goal ? Get ISS to change its mind again about who to support in the proposed merger, still scheduled for early March. The BDC Reporter will be undertaking an annotated review of the arguments made by Mr Ainsberg, who explicitly claims “We are not a hand tool of management”, for our Premium subscribers shortly. This week, we’ll be watching to see how ISS, NexPoint and anybody else with the ability to issue a press release, responds.

More Earnings: After a quiet week where we heard from Ares Capital (ARCC), whose results were very good and Medley Capital (MCC), whose results were very poor, four more BDCs will be reporting results. These are TPG Specialty (TSLX); Hercules Capital (HTGC); Solar Capital (SLRC) and Solar Senior Capital (SUNS). The BDC Reporter’s Earnings Calendar provides the date of both the releases and the subsequent Conference Calls. All are larger, well established BDCs and all are expected to report earnings in line with analyst expectations. Moreover, all have loan portfolios in good shape through September 2018. We’ll be looking for any blots on those clean sheets. As always, the BDC Reporter believes that what happens on the credit front is much more important than whether earnings are a penny or two different from what the analyst consensus might be. Those prospective credit cracks in the fuselage may have little impact in the short term but could result in a future disaster.

Markets: As our Premium readers know from our weekly Market Recaps of both the BDC common stock and fixed income markets, there is an ongoing rally that began Christmas Eve and has continued with nary a pause ever since. As ever, we do not pretend to know where the markets are going to go from here, whether upward, downward or sideways. Nonetheless, the importance of staying abreast with market sentiment has rarely been greater. With all BDC common stocks way off their lows, and many reaching back to their 52 week highs, the question of what happens next is critical. For example, CEF Advisors wrote to tell us “our BDC index just bumped above the recent Feb 5th high and matched (within 0.1) of the Aug 30 2018 high”. Like Icarus – and because of their structure – BDC common stock prices can only fly so high before falling to earth. The better the price performance, the higher the risk of a change of sentiment leading to a plunge, as our now thirteen years of being involved in this sector have shown. What is happening in the broader stock markets and to non-investment grade credit will offer many clues.

More granularly, we’ll also be keeping a special eye out for how Harvest Capital’s (HCAP) stock price fares after the BDC’s just announced dividend reduction – the second in one year. As we’ve done for weeks, we’ll be monitoring MCC and MDLY’s stock price for hints about how the market expects the merger vote to go.

Twitter Feed: We remind readers who want to keep up with BDC developments in almost real time and more comprehensively than you’ll find anywhere else to follow us on Twitter. We post most everything we find in our daily coverage of the sector, with some brief analysis thrown in. Last week we posted 40 items drawn from BDC press releases, SEC filings and material price changes, usually within minutes or hours of their arrival in the public arena. Much of what we’ve covered above will turn up on that Twitter feed which can also be found on the front page of the BDC Reporter. If you have not already, please sign up. Sorry, no cat videos, celebrities or political commentary. Just BDC news, analysis and views from the BDC Reporter.

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